Uncle Sam can reach into your individual retirement account if you owe back taxes. However, any money the Internal Revenue Service takes from your IRA is free from the early withdrawal penalty. You can dissolve an IRA at any time, whatever the reason, though you may have to pay taxes and penalties. You generally can avoid a penalty if you qualify for certain exemptions, including IRS garnishment.
If you dissolve your retirement account, you pay your regular tax rate on the money you take out of traditional IRA, except for nondeductible contributions. You never pay taxes when you withdraw those contributions, or cash you've contributed to a Roth IRA, since you've already paid income taxes on this money. You also don't owe taxes on qualified distributions of earnings, or investment gains, from a Roth IRA. Those withdrawals are qualified if you are age 59 1/2 or older and have held the account at least five years.
Taxes and Penalties
You can face taxes and penalties for several infractions. If you spend more than 60 days to roll over an IRA, the IRS will hit you with the same penalties and taxes, if any, that you would pay for a simple withdrawal. The agency will charge you an annual tax of 6 percent for excess contributions you fail to remove by the tax filing deadline. The IRS requires you to take a required minimum distribution from a traditional IRA by April 15 of the year following your 70 1/2 birthday and by each Dec. 31 from then on. You calculate your RMD using the life-expectancy charts in IRS Publication 590. The IRS will charge a 50 percent tax on the money you fail to take out as part of your RMD.
The IRS can legally seize your property, including your IRAs, to satisfy a tax debt. The procedure requires the agency to first send you a notice of demand for payment. If you don't pay the tax, it sends a final levy notice at least 30 days before the final levy. An IRS agent may drop by your home to hand you the final notice or send it to your workplace or last known address. The IRS will work with you if you claim hardship, and you can ask for a "collection due process" hearing within 30 days of the final notice. If the hearing doesn't go your way, you have another 30 days to file an appeal. Publication 1660 describes your appeal rights. If you fail to dissolve your IRA after exhausting all appeals, the IRS may dissolve it for you and grab the proceeds. Either way, you'll owe taxes on the taxable distribution, but at least you'll avoid the 10 percent penalty.
You might preserve your IRA if you can find another way to satisfy the IRS. You might be able to sell assets or use other savings to pay your tax debt. You can also apply to "offer in compromise," using forms 656 and 433. The IRS might consider your offer to settle a tax bill for less than the full amount, but you must jump through several hoops detailed in Booklet 656. If you negotiate a compromise, the agency may leave your IRA intact and find other ways to give you a fresh start.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.